Does Article III of the Constitution permit bankruptcy courts to enter final judgments in “core” proceedings as defined in 28 U.S.C. § 157(b)? If not, can bankruptcy courts exercise jurisdiction over litigants through their “implied consent”?
In 2011, the Supreme Court held in Stern v. Marshall that bankruptcy courts are constitutionally barred from granting final judgments on certain “core” state law claims. Since then, lower courts have tried to determine the scope of the holding, which addresses bankruptcy courts’ ability, as non-Article III courts, to preside over issues traditionally considered to be core bankruptcy issues. Petitioner, Executive Benefits Insurance Agency, (“EBIA”) was a third party to a bankruptcy proceeding. The bankruptcy court found that the debtor in the proceeding had fraudulently transferred $373,291.28 to EBIA before filing for Chapter 7 bankruptcy. The bankruptcy trustee, Arkison, sued EBIA to recover those funds, and the bankruptcy court granted a judgment against EBIA. EBIA appealed and invoked Stern v. Marshall, claiming that the bankruptcy court could not enter a final judgment on a fraudulent transfer claim. The district court and Ninth Circuit affirmed the bankruptcy court, reasoning that EBIA had impliedly consented to the bankruptcy court’s jurisdiction. The Supreme Court’s ruling in this case will clarify the limits of Stern v. Marshall and define “core” bankruptcy proceeding. The Court will also determine what kind of consent is necessary for bankruptcy courts to have jurisdiction over claims requiring adjudication by Article III judges.
In Stern v. Marshall, 131 S. Ct. 2594 (2011), this Court held that Article III of the United States Constitution precludes Congress from assigning certain “core” bankruptcy proceedings involving private state law rights to adjudication by non-Article III bankruptcy judges. Applying Stern, the court of appeals for the Ninth Circuit held that a fraudulent conveyance action is subject to Article III. The court further held, in conflict with the Sixth Circuit, that the Article III problem had been waived by petitioner’s litigation conduct, which the court of appeals construed as implied consent to entry of final judgment by the bankruptcy court. The court of appeals also held, in conflict with the Seventh Circuit, that a bankruptcy court may issue proposed findings of fact and conclusions of law, subject to a district court’s de novo review, in “core” bankruptcy proceedings where Article III precludes the bankruptcy court from entering final judgment. The court of appeals’ decision presents the following questions, about which there is considerable confusion in the lower courts in the wake of Stern:
- Whether Article III permits the exercise of the judicial power of the United States by bankruptcy courts on the basis of litigant consent, and, if so, whether “implied consent” based on a litigant’s conduct, where the statutory scheme provides the litigant no notice that its consent is required, is sufficient to satisfy Article III.
- Whether a bankruptcy judge may submit proposed findings of fact and conclusions of law for de novo review by a district court in a “core” proceeding under 28 U.S.C. 157(b).
Nicholas Paleveda and Marjorie Ewing, a married couple, operated a series of companies, including Aegis Retirement Income Services, Inc. (“ARIS”) and the Bellingham Insurance Agency, Inc. (“BIA”). See Exec. Benefits Ins. Agency v. Arkison (“EBIA”), 702 F.3d 553, 556 (9th Cir. 2012). The companies were closely related, with Paleveda and Ewing owning 100% of ARIS and 80% of BIA, and Paleveda and Ewing alternating as sole director of ARIS and general manager. See id. ARIS and BIA shared an office and phone number, and ARIS routed all of its income and expenses through BIA, kept joint records with BIA, and declared its income on consolidated tax returns with BIA because ARIS lacked sufficient funds to operate independently. See id.
In early 2006, BIA became insolvent and filed for Chapter 7 bankruptcy in the United States Bankruptcy Court for the Western District of Washington. See EBIA, 702 F.3d at 557. In the meantime, BIA had irrevocably assigned the insurance commissions from its largest client to Peter Pearce, a long-time BIA and ARIS employee. See id. at 556. Additionally, Paleveda had used BIA funds to incorporate the Executive Benefits Insurance Agency, Inc. (“EBIA”), and Pearce and EBIA deposited $373,291.28 of commission income into an account jointly held by ARIS and EBIA. See id. at 556–57.
Peter Arkison, the Respondent and bankruptcy trustee, sued EBIA and ARIS to recover the commissions deposited into the EBIA/ARIS account, claiming they were fraudulent transfers under the Bankruptcy Code, 11 U.S.C. § 548, and Washington’s Uniform Fraudulent Transfer Act, Wash. Rev. Code § 19.40.041. See EBIA, 702 F.3d at 557. The bankruptcy court granted summary judgment in favor of Arkison, and concluded that EBIA was liable for BIA’s debts as a corporate successor, and the district court affirmed. See id.
EBIA appealed and invoked Stern v. Marshall in a motion to vacate the bankruptcy court’s judgment for lack of subject-matter jurisdiction. See id. EBIA claimed that the bankruptcy judge could not enter a final judgment on Arkison’s claims. See EBIA, 702 F.3d at 557. The Ninth Circuit held that the bankruptcy court’s judgment was final because EBIA had consented to the bankruptcy court’s jurisdiction. See id. at 573. However, the court also noted that, consistent with Stern v. Marshall, Article III bars bankruptcy courts from entering final judgments in actions brought by a noncreditor without the party’s consent. See id.
This case allows the Supreme Court to clarify its holding in Stern v. Marshall. Before Stern, courts assumed that a bankruptcy court could enter a final judgment on “core” matters as codified in the Bankruptcy Code. See Brief for Certain TOUSA Defendants in Support of Petitioner at 9. Stern rejected the idea that Congress granted bankruptcy courts authority to issue final judgments in § 157(b)(1) and (2) actions. See id. at 10. In Stern, the Supreme Court narrowly held that a bankruptcy court can preside over actions stemming from bankruptcy but not over state law claims independent of the bankruptcy action. See Regina Stango Kelbon, Lora M. Epstein & Alan M. Root, The Aftermath of Stern v. Marshall: The Bankruptcy Court’s Power to Hear and Decide Fraudulent Transfer, Mondaq (April 17, 2012). Specifically, the Court held that the Constitution prohibits bankruptcy courts from adjudicating counterclaims to proofs of claims, even though such actions are permissible under 28 U.S.C. § 157(b)(2) as “core” traditional bankruptcy claims. See Jason J. DeJonker & Christal A. Delgado, Ninth Circuit “Stern” Decision Creates a Circuit Split on Issues of Article III Waiver and the Statutory Gap, 10:1 ABI Bankruptcy Litigation Committee Newsletter (Feb. 2013). Since Stern, federal courts have divided over bankruptcy courts’ ability to enter final judgments in adversarial proceedings and to preside over other “core” claims. See id.
Arkison’s supporters argue that bankruptcy courts must retain their ability to preside over fraudulent transfer claims because such actions are the only way to adequately restructure the relationship between creditors and debtors in bankruptcy proceedings. See Brief for Irving H. Picard, as Trustee of the Substantively Consolidated Estate of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoffin Support of Respondent at 20. Amici in support of Arkison contend that without the ability to rule on fraudulent transfers, bankruptcy courts will be unable to craft sufficient remedies in situations where debtors hide their assets from creditors before declaring bankruptcy. See id. at 27. Moreover, amici argue that stripping bankruptcy courts of their ability to adjudicate fraudulent transfer claims would burden creditors with longer delays and add more uncertainty to bankruptcy proceedings. See id. at 30. Specifically, Arkison’s supporters warn that district courts would be burdened with adjudicating previously “core” issues, such as fraudulent transfer claims. See id. Aside from causing delays, Arkison’s supporters claim that assigning traditionally core bankruptcy matters to district courts would burden district courts by overcrowding their dockets with unfamiliar bankruptcy cases. See id. at 31. Further, Arkison’s supporters claim that speedy resolutions are essential to bankruptcy’s primary purpose – prompt and orderly resolutions of bankruptcy estates for creditors’ benefit. See id. at 32.
EBIA’s supporters argue that allowing bankruptcy courts to preside over certain core issues like fraudulent transfers would be unfair and inefficient. See Brief for the Robert R. McCormick Foundation and the Cantigny Foundationin Support of Petitioner at 11. According to these amici, including the Robert R. McCormick Foundation, bankruptcy judges lack the constitutional authority and training of Article III judges to adjudicate over claims involving private rights. See id. EBIA’s supporters contend that only district courts have the authority to adjudicate such matters. See id. Additionally, they argue, district courts can delegate preliminary fact-finding and non-binding decision-making to magistrate judges. See id.Supporters of EBIA further argue that magistrate judges are just as capable of handling former core bankruptcy claims, and their authority to do so is well established under 28 U.S.C. § 636. See id. at 12. Because magistrate decisions are subject to reconsideration by the district court when they are clearly erroneous and bankruptcy judges are not, amici for EBIA assert that magistrate judges better serve the interests of fair administration of civil justice when presiding over claims requiring an Article III judge. See id.
In this case, the Supreme Court will decide whether a bankruptcy judge can issue a final judgment on a non-core bankruptcy issue when the litigants consent to the judge’s ruling; the Court will also consider whether that consent can be implied. If the Court holds that consent does not authorize bankruptcy judges to issue final judgments or that consent cannot be implied, then the Court will decide whether bankruptcy judges can submit findings of fact and conclusions of law to a district court judge for a “core” proceeding as defined by 28 U.S.C. 157(b).
In Stern v. Marshall, the Supreme Court examined “core” bankruptcy issues under 28 U.S.C. 157(b). See Brief of Petitioner at 9. The Court determined that judges lack constitutional authority to grant final judgments in certain core proceedings. See Brief of Petitioner at 9. The categories “core” and “non-core” are exhaustive, which means that Stern did not create another category of bankruptcy claims. See Brief of Respondent at 4. Instead, Stern clarified that some statutorily “core” issues are unconstitutional, and must therefore be considered non-core because Congress incorrectly drew the line between core and non-core. See id. at 47. However, the Stern holding also suggested that bankruptcy court adjudications can violate the separation of powers doctrine because bankruptcy judges are not Article III judges and do not have the independence and protection of life appointments. See Brief of Petitioner at 13.
EBIA argues that the constitutional issue raised in Stern cannot be cured by parties consenting to the litigation. See Brief of Petitioner at 36. Arkison responds that Stern should be construed narrowly, and that the parties’ consent to litigation is constitutional, similar to the workings of federal magistrate courts. See Brief of Respondent at 18, 20. EBIA further argues that Stern has left a statutory gap in the bankruptcy statute which does not allow bankruptcy judges to adjudicate certain core issues or to issue findings of fact or law. See Reply Brief of Petitioner at 20. Arkison argues that there is no statutory gap because although bankruptcy judges cannot grant final judgments on the core issues discussed in Stern, they can give findings of fact and conclusions of law to district court judges for final judgment. See Brief of Respondent at 63–64.
CAN BANKRUPTCY COURTS DECIDE NON-CORE ISSUES WHERE THERE IS PARTY CONSENT?
The first issue for the Court is whether bankruptcy courts can grant final judgments on non-core issues with party consent, and if so, whether that consent can be implied.
EBIA argues that the Article III constitutional violation identified in Stern cannot be cured by individual party consent. See Brief of Petitioner at 16. EBIA contends that the separation of powers doctrine preserves the respective authority of the separate branches, and even an agreement between branches cannot alter this balance. See id.at 18.In EBIA’s view, reallocating power within a branch can violate this doctrine, and because agreements between the branches of government cannot alter the balance of power, neither can individual agreements. See id. at 19. EBIA argues that giving non-Article III judges—judges who are not protected by permanent appointment—the power to grant final judgments reallocates power within the judicial branch. See id. at 21–22. EBIA further contends that if consent could cure this breach, it would have to be explicit in the statute; but this protective limitation does not exist in the bankruptcy statute as it does in the Federal Magistrates Act. See Reply Brief of Petitioner at 6.
Arkison argues that individual party consent can rectify the Article III concern raised in Stern because Article III is concerned with private individual rights more than structural rights, which are not implicated in private party litigation. See Brief of Respondent at 22. Furthermore, Arkison explicates the long history of the use of special masters, magistrate judges, and bankruptcy “referees” or judges who are not Article III judges but can grant final judgments. See id. at 9–16. Arkinson contends that modern precedent has supported the continued use of judges in this context, particularly federal magistrate judges, when the parties consent to the litigation. See id. at 25. Arkison also asserts that Stern approved this historical practice by recognizing core and non-core bankruptcy issues. See id. at 29–31. Arkison further contends that when there are fatal constitutional flaws in Article III regimes, it is the lack of consent, not the lack of Article III protections such as judge permanency, that raises concerns. See id. at 31–32. Arkison thus emphasizes that there is no Article III violation when magistrate and bankruptcy judges receive parties’ consent to adjudicate their claims. See id. at 38, 46–48.
EBIA argues that if consent authorizes bankruptcy judges to grant final judgments on non-core issues, then the consent must be actual, not implied. See Brief of Petitioner at 38. EBIA asserts that under the Federal Magistrate Act, consent must be knowing and voluntary, and this same standard should be applied to the bankruptcy courts. See id.at 39. EBIA further argues that its consent was not knowing or voluntary here because it was forced on EBIA by the binding Ninth Circuit precedent at the time. See id.at 42. In EBIA’s view, a failure to object because of precedent does not constitute voluntary consent. See id.EBIA maintains that a finding of implied consent would contravene Article III principles that require robust protection for litigants. See id.at 46.
Conversely, Arkison claims that constitutionally permissible consent can be implied, as it was in Roell v. Withrow, which held that implied consent is sufficient to give federal magistrate judges adjudicatory power. See Brief of Respondent at 51. Arkison contends that because EBIA received full Article III consideration through the appeal process, the Court need not reach the consent issue because the procedural posture of this case does not necessitate it. See id. at 57–58. However, Arkison argues that if the Court chooses to decide this issue, EBIA fully consented to jurisdiction by the bankruptcy. See id. at 54. In Arkison’s view, EBIA knew that it had to object to the bankruptcy court’s jurisdiction, but failed to do so. See id. at 60. Accordingly, Arkison argues that EBIA took a risk, but should not have a second chance simply because they lost. See id. at 62.
CAN BANKRUPTCY COURTS ISSUE FINDINGS OF FACT AND LAW ON CORE ISSUES?
If the Court determines that EBIA’s implied consent was not actual consent, the Court will determine whether bankruptcy judges can issue findings of fact and conclusions of law on core bankruptcy issues.
EBIA argues that bankruptcy judges, under 28 U.S.C. § 157, cannot issue proposed findings of fact or conclusions of law in core proceedings. See Brief of Petitioner at 46. According to EBIA, the statute authorizes bankruptcy judges to issue final judgments, but not proposed findings, in core bankruptcy proceedings. See id. at 47. However, EBIA claims, bankruptcy judges can issue proposed findings in non-core proceedings. See id.EBIA asserts that this gap in the statute must be rectified by Congress, not the courts. See id.In EBIA’s view, because Congress overstepped constitutional bounds by writing the statute, only Congress can amend the statute because a judicial correction would violate separation of powers. See Reply Brief of Petitioner at 23.
Arkison acknowledges that at first glance, there appears to be a statutory gap because the claims made unconstitutional by Stern are still considered core under 28 U.S.C. § 157. See Brief of Respondent at 63–64. However, Arkison asserts that Stern’s holding that “core” and “non-core” are exhaustive categories means that statutorily core claims that are unconstitutional under Stern must be considered “non-core.” See id. at 64. Accordingly, Arkison argues that because the claims must be viewed as non-core, there is no statutory gap at all. See id. at 65–66. Moreover, Arkison contends, the statute should be interpreted as allowing bankruptcy judges to enter judgments, rather than requiring final judgments for core issues. See id. at 65–66. Arkison claims that Congress could not have intended to grant bankruptcy courts more power over non-core issues (by allowing bankruptcy courts to issue findings of fact and conclusions of law) than over core issues (by preventing bankruptcy courts from issuing findings of fact and conclusions of law). See id. at 67.
In this case, the Court will determine whether bankruptcy judges can grant final judgments on non-core bankruptcy issues when the parties consent, and if so, whether that consent can be implied. The Court will also decide whether bankruptcy judges can issue findings of fact and conclusions of law on core bankruptcy issues. EBIA argues that bankruptcy judges cannot grant final judgments on non-core bankruptcy issues because party consent cannot cure the Article III constitutional issue that was raised in Stern. If consent can cure this defect, EBIA argues that it cannot be implied. Arkison argues that if there is consent, bankruptcy judges can grant final judgments on non-core issues, and that consent can be implied. Whereas EBIA contends that bankruptcy judges cannot issue finding of facts and conclusions of law on core issues because of a statutory gap created by Stern, Arkison argues that the power to issue these findings is implied in the statute and not affected by Stern. The decision in this case could have wide-ranging implications for the bankruptcy courts, and possibly the federal magistrate system. The Court will have the chance to clarify its holding in Stern, and may urge Congress to enact legislation to fix the bankruptcy courts.
- Shari Bedker, National Bankruptcy Conference Releases White Paper on Executive Benefits Insurance Agency v. Arkison, (Dec.10, 2013).
- New York Law Journal, Analyzing The Post-'Stern' Landscape In New York, (Dec. 6, 2013).